(7.1.a) Opportunity costs

(A) Opportunity cost—the good, the bad, and the ugly

Research has shown that less physically attractive people are more likely to commit crimes. This does not surprise the economist, who is quick to point to the concept of opportunity cost as an explanation. Data on people's income, health, and happiness make clear that less attractive people make less money, experience poorer health, and experience higher rates of depression.

This means they have less to lose from going to jail. They do not leave behind the high paying job or the beautiful spouse. Some may find prison to be about the same or better than their normal life.

Opportunity Cost—the value of the next best alternative

The definition of opportunity cost is: the value of the next best alternative. Committing the crime has a certain benefit, otherwise it would not be considered. The alternative to committing the crime is assurance you will not go to jail. The value of your non-prison life is higher for the attractive person, so the opportunity cost of crime to them is higher. Thus, they are more reluctant to break the law.

(B) Opportunity cost—Roman soldiers

The Romans understood opportunity cost well. In the days of the Roman Republic they would conscript and give command to the wealthiest Romans for the important battles, under the assumption that a wealthy Roman has more to lose by fighting wars foolishly, and thus make better soldiers.(E1)

(C) Opportunity cost—see Wilco in concert?

If you are given a free ticket to see Wilco, the cost of the concert is not free, it is what you would have done if you didn't go to the concert, and how much you value that alternative. If you have nothing better to do, you go. If you have the opportunity to see a band you like better you might skip the Wilco concert, even if this preferred band costs money.

(D) Opportunity cost—pesticides and radon

The concept of opportunity cost is essential for effective governance. For example, should we try to save lives by banning the use of pesticides in agriculture? Some studies suggest that banning all pesticides would cost us about $20 billion and save 20 deaths per year. That’s $1 billion per life saved. If you really want to save lives, use that $20 billion for radon testing in homes, which will save about 15,000 lives.(N1)

Thus, spending $20 billion to save 20 lives is a poor way to spend money, especially when you recognize that doing this forgoes the opportunity to spend that money for radon testing and save 15,000 lives.

Video 1—Ethicist Peter Singer on the opportunity cost of helping blind people (TED Channel, May 20, 2013)
(View entire TED talk at http://www.youtube.com/watch?v=Diuv3XZQXyc)

Another consideration is the fact that banning pesticides would increase the price of fruits and vegetables, lowering consumption of these healthy foods and perhaps causing an increase in cancer rates (and other health problems). A wise government truly intending to improve health would not only consider the effects of eliminating use of pesticides, but also subsidizing fruits and vegetables.

(E) Opportunity cost—the cost of raising crops

Suppose it costs a farmer $100 per acre to produce wheat and she receives revenues of $250 per acre. What is the cost of wheat production? Not $100, if we are talking about opportunity cost. She made a profit of $150 per acre growing wheat, but what profit could she have made growing the next most profitable crop? If the next best alternative is grain sorghum, and she could make $80 per acre, then the opportunity cost of wheat production is $80 acre.

Why do economists care more about opportunity costs than accounting costs? Because it's opportunity costs that influences a person's behavior. After all, if the opportunity cost of wheat production was $-20 per acre (because grain sorghum is more profitable) she wouldn't grow wheat in the first place, regardless of wheat's accounting cost of production.

(F) This guy understands opportunity cost

   DAN LINDSTROM remembers looking at a piece of Nebraska farmland six or seven years ago that cost $3,300 an acre. Raised on a farm, he ran the numbers with his brother who is farming the family land and concluded that it was too expensive. He figured that with a 2 to 3 percent return, it made more sense to put the money into a dividend-paying stock and have his brother lease additional land.
   A few weeks ago, Mr. Lindstrom said similar land sold for nearly $11,000 an acre.
—Sullivan, Paul. August 16, 2013. “Despite Drop in Commodity Prices, Farmland Values Rise.” The New York Times.

(G) Obesity and opportunity costs

Video 2—Welcome to the Land of Obesity(N2)

Obesity has risen considerably since the 1970’s, but why? There are many plausible reasons, such as a decrease in the price of food, greater use of air conditioners, decreases in smoking, fewer physical demands at the workplace, and the like. These explanations do not match the data though, because they do not explain the fact that obesity was increasing at only a slow rate until the 1980’s, after which it surged upwards.

TABLE 1—Change in Caloric Consumption for Americans Over Time(C1)
  Percent Change in Calories Consumed Between 1970’s and 1990’s
Breakfast 13%
Lunch 19%
Dinner -22%
Snacks 90%

Economists have suggested that changes in food processing explain the rise in obesity rates. Food prices had been steadily declining long before the 1980’s, but during that decade food became much more convenient, especially snacks. The time it took to prepare food  declined so much that the act of snacking took much less time, so while calories eaten at meals did rise calories from snacking rose even more. So it is not a lower price of food that causes obesity, at least not the price at the store. The opportunity cost of food fell, as people had to give up far less of their valuable time to snack, and so they snacked more—and more and more and more.(T1)

Figure 1—U.S. Obesity Rates Over Time

Taken from http://lanekenworthy.net/2012/05/31/why-the-surge-in-obesity/

(H) Homer Simpson ignored opportunity costs

Video 3—Homer Simpson ignores an important cost(G1)

Perhaps the best illustration of opportunity cost was demonstrate in The Simpsons, where Homer doesn’t account for the opportunity cost of the money he spends on bacon when he fries bacon to produce and sell bacon grease. It isn’t a perfect example, because even Homer’s accounting profits would be negative, but it is a good metaphor for how business is conducted when opportunity costs are ignored. For example, a corporation should not brag about making accounting profits if these profits provide their shareholders a 1% rate of return. The reason is that the shareholders could have invested in thousands of other things that would surely earn more than 1%. In reality, holding the stock causes stockholders to lose money—when profits account for opportunity costs—because they could have made more money elsewhere. This is captured keenly in the following dialogue from Silicon Valley.

Video 4—Better off just putting the money in a CD (certificate of deposit)


(C1) Cutler, David M., E. L. Gleaser, and J. Shapiro. 2004. "Why have Americans become more obese? Journal of Economic Perspectives. 17(Summer):93-118.

(E1) Everitt, Anthony. 2012. The Rise of Rome. Random House: NY, NY.

(G1) Groening, Matt [creator].Jean, Al. [Executive Producer]. Maxtone-Graham, Ian, John Frink James L.Brooks, Matt Groening, Matt Selman, and Sam Simon [producers]. O'Brien [writer]. Polcino, Dominic [director]. August 23, 1998. "Lard of the Dance." The Simpsons. Gracie Films and 20th Century Fox Television [Production companies]. 20th Television [distributor].

(N1) Norwood, F. Bailey and Jayson L. Lusk. 2008. Agricultural Marketing and Price Analysis. Pearson / Prentice-Hall: NY, NY.

(N2) National Geographic. October 8, 2013. Extreme Obesity. Accessed October 13, 2013 at http://www.youtube.com/watch?v=NfxFn1IqHo4&list=TLFS81vSgu3fwCv0R-g0YX5ZEnoi0YfjZi.

(T1) Taylor, Timothy. 2011. Unexpected Economics [lectures]. Lecture 20: Obesity—Who Bears the Costs? The Great Courses. The Teaching Company.